RuthMantell

It’s clear that builders in recent months have slowed down the pace of construction started on new homes. But what’s less clear is how much of that drop was due to bad weather.

“The continued unseasonably severe weather probably played some role in keeping starts subdued last month. After all, the biggest drop in starts was in the Northeast, where temperatures were particularly low,” Paul Diggle, an economist at Capital Economics, said in a research note.

For the country as a whole, here’s one disturbing trend: Last month the seasonally adjusted annual rate of housing starts dropped below the year-earlier level for the first annual decline since August 2011. On a brighter note, the pace of home-building permits, a leading indicator for construction, rose in February from the year-earlier period.

“[There’s] a considerable shortfall between the current and required level of housing starts,” Diggle wrote. “The...rise in building permits suggests that home builders will start making up this gap next month, and we expect them to go a lot further over the next year.”

If weather is the real culprit behind recent housing-market weakness, and other investors are incorrectly pricing in a seasonal blip, then it could be the right time to invest in builders. But if you think that the underlying trend in demand for new homes is sputtering, and that builder stocks are trading too high, then the housing sector may not be your best bet.

There are other factors to consider, too. Builders are pessimistic over sales trends for single-family homes, and say they are concerned about shortages for buildable lots and skilled workers, and higher material costs. And while builders have been able to pump up revenue by cranking prices higher, eventually they’ll need to find a new strategy or buyers will be priced out.

Key for shares this year is how the companies will perform during the all-important spring selling season. Just last week Lennar and KB Home KBH, +1.35%
reported that revenue jumped in the fiscal first quarter from the year-earlier period. But those results don’t say much about spring sales, other than that trends are decent, and one can hope for some momentum.

Stuart Miller, Lennar’s chief executive, said that it is too early make predictions about spring home sales, but that he is optimistic about the market’s recovery.

“The fundamental drivers of that recovery remain intact,” Miller said. “The housing market is still in the early stages of recovery.”

There certainly is room for home-construction rates to grow. The annual pace of housing starts fell to a seasonally adjusted 907,000 last month, far fewer than the 1.7 million starts per year economists estimate are needed to keep up with population growth and meet demand for replacement and second homes.

But here’s a darker view of the current state of the housing market: It’s been more than four years since the recession ended, and household formation remains low. Indeed, Federal Reserve Chairwoman Janet Yellen noted last week that household formation is “very depressed,” as many young adults are “shacking up with their families,” rather than setting up a establishing a new home.

Measures of homeownership and home buying signal that young families are having a tough time in this housing market. Even those who have been able to find a job will find it tough to put together enough cash for a down payment.

It’s worth investors’ while to pay attention to trends among young buyers. These families are a key chunk of the housing market — their purchases enable other families to move into nicer and pricier places, such as a newly-built home. For young buyers, many of whom haven’t accumulated much wealth, job creation is particularly important to support their demand, and recent trends labor-market trends show weakness. Over the quarter that ended in February, the economy added an average of 129,000 nonfarm jobs per month, down from an average of 230,000 in the year-earlier period, according to government data.

Still, there’s hope for the housing market this year. Rates for fixed-rate mortgages, which climbed about one point over the past year, remain relatively low, and “should serve as a stimulus to people coming back into the housing market,” Yellen said.

“I do expect housing activity to begin to expand more rapidly,” Yellen said in response to a reporter’s question about whether keeping rates low is an effective strategy.

The above analysis covers big-picture questions. Investors interested in a more nuts-and-bolts approach to consider builders’ prospects can evaluate companies’ liquidation value. Robert Wetenhall, an analyst at RBC Capital Markets, did just that on Friday and found that the builder sector was trading, on average, at a 9% premium to its liquidation value, “suggesting limited downside.”

However, details of Wetenhall’s estimate show that certain stocks are pricier than others. Shares of both D.R. Horton and Toll are trading at more than 20% above liquidation value, while Brookfield Residential Properties
US:BRP
and K.B. Home shares are trading at a discount, Wetenhall estimated.

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